Economics of digital media

<p><em>Romesh Vaitilingam interviews Joel Waldfogel for Vox</em></p>
<p><em>January 2010</em></p>
<p><em>Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/4536</em></p>
<p><strong>Romesh Vaitilingam</strong>: Welcome to &quot;Vox Talks,&quot; a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam. Today's interview is with Professor Joel Waldfogel of the University of Pennsylvania's Wharton School. Joel and I met in London in December 2009, where we spoke about the impact of new technology on the economics of digital media, including music, the movies, and books and newspapers. We began with Napster and Joel's research on the impact of illegal music file sharing on revenues to records labels and artists.</p>
<p><strong>Joel Waldfogel</strong>: Well after Napster, it was so much in the news about this threat to record labels, threats to revenue for recorded music. Napster grew just enormously and so many people were, &ldquo;stealing&rdquo; I guess is the right word, stealing music, especially on college campuses. So I was surrounded by this phenomenon. As an old guy, being over 30, maybe even over 40, old guys buy music, and young guys, at the time, just stole music. And there's a generational divide in views about what's an appropriate way to deal with recorded music. In any event, I wanted to figure out to what extent the decline in music sales was attributable to the piracy, to the file sharing activity.</p>
<p>Since this illegal behavior, it's not easy to observe it. You can't just go look at the government statistics on it. So you've got to find some clever way to collect data. And a variety of authors have found a variety of clever ways.</p>
<p>But what I did, I just went ahead and surveyed students. So I gave them lists of, at that time, albums that had released in the past three years. This was in 2003 or so. I just asked them, for each of these albums, &quot;Do you possess it? How did you obtain it?&quot; I also asked them about their willingness to pay for it.<br />
With those data, I was able to try to do some kind of sales displacement estimates. And I came to the view that the rate of sales displacement was about .25, meaning if I steal four, I buy one fewer. Now, that's interesting because on the one hand to the extent that it applies to the whole universe of music buyers it would mean that the file sharing activity is harming revenue of the music business.</p>
<p>But, at the same time, because it's nowhere near one for one displacement, it means a lot of the stuff that was being stolen is stuff that would not have otherwise been purchased. So when you think about it, a demand curve and a positive price is zero marginal cost. You've got some consumer surplus, some revenue, and some dead weight loss. That is, some transactions that aren't taking place, even though the valuation exceeds the zero marginal cost.</p>
<p>Well, stealing is just a form of do it yourself price discrimination, where you take something and you just take it. To the extent that the folks stealing would not have been purchasing, at the price where it was offered, well that's just a welfare improvement. And it doesn't harm the sellers.<br />
Anyways, because the rate of sales displacement was not one for one, a lot of the stealing was not harmful to sellers but just beneficial to buyers. So there's sort of something for everyone in those results. Yes, part of the harm to the industry is being caused by stealing, but there's a benefit to stealing, that it's not coming off the backs of the sellers.</p>
<p><strong>Romesh</strong>: OK, let's think about that in a little more detail, about who are the real losers from this shifting technology? The music industry, the record companies say &lsquo;we're the big losers and this is a battle we've been fighting for years, even when we used to print &quot;Do not home tape this long playing record.&quot;&rsquo; And they're saying,&rsquo; now you've got the technology to do it and you're all doing it and you're driving us out of business&rsquo;. Some of the musicians say, &lsquo;it's bad for us. It's hurting us&rsquo;. Well, you could say, actually what's it's creating is a situation where musicians won't create new music. So we're all going to be ultimately losers, because we're not going to get such great music in the future. Who are the losers?</p>
<p><strong>Joel</strong>: Well, the losers are clearly the labels and the established artists. A lot of the income that the artists earn, though, particularly the less&hellip;the not super, super famous ones, is from live music. So recorded music is a complement for live music. In some ways, a lot of artists have moved toward the view, I can't control the recorded stuff so I'll just give it away as a promotional device in some sense, to help sell the appropriable stuff - the recorded music, the T shirts, and so forth.</p>
<p>And a related view is that artists don't produce for financial reasons. They're just artists. Having said that, I think there's a great quote. I think John Lennon and Paul McCartney are sitting around saying &lsquo;let's write ourselves a swimming pool&rsquo;.</p>
<p><strong>Joel</strong>: But in any event, the jury's a little bit out on that. But I don't think we're going to not have art. But we're not going to have whatever it was that labels were producing, some kind of promotional activity, some kind of searching among the potential artists to promote. The jury's out on how important those functions are. I think we'll have music. We'll just have less of whatever the labels were doing.</p>
<p><strong>Romesh</strong>: Can we think a little bit about the incentives to the purchasers, or non purchasers in the case of many younger people, of music, what the incentives are? I sometimes think, is it because, when you and I were kids, what you bought was a physical product? You went out and you bought a black,12 inch, long playing album. And what kids buy is something kind of intangible. They download it off the internet, it comes in, they listen to it. There's no real physical product there.<br />
Joel: Yeah, I think it feels like a victimless crime to them. I think that's right. In our day, when we were buying vinyl and recording it on cassettes, even though the labels were upset about that, it's not at all obvious that was harmful to them. Because, suppose an album cost, well, in today's dollars, $15. If I valued it at $8, and you valued it at $8, if we were to form a little club between us and everything I purchase, I'll record for you, and everything you purchase, you'll record for me. A lot of stuff, that individually wouldn't have been worth buying, will be worth buying in these mini collectives.</p>
<p>In the old days, recording vinyl to cassette produced sort of bad...the first generation copy was OK, but a second generation copy would be terrible. So copying was small scale by nature.</p>
<p>So it's not even obvious that copying, in the old days, was harmful. This is how I justify my misspent youth. But, today, of course, nth generation copies are equally good as originals.</p>
<p>So, I think it's very hard to argue, today, that copying isn't harmful to the sellers of the recorded music. Again, the artists, the extent that they can make money on compliments to recorded music, they may or may not be harmed. But the record labels clearly are harmed.</p>
<p><strong>Romesh</strong>: It seems to me also that we've seen quite a change in the packaging of music. On the one hand, there's the issue you mentioned, people are much more out on the road, because they need to make their money out of playing live. We see all these old bands going and playing places like Jones Beach, all through the summer. But, on the other hand, you see the packaging in a different way. We don't really see albums as an idea. People buy individual songs rather than collections of songs. It seems to be a big shift.</p>
<p><strong>Joel</strong>: That's right. One of the reasons I think that piracy took off so quickly, is at the time Napster appeared, a consumer had essentially a choice between buying 12 songs on a physical CD, and of those 12 songs maybe he wanted 3. Or he could steal individual songs for zero price, maybe plus some fear of getting caught. Although in 1999, there wasn't much fear. And in some ways I don't mean to entirely blame the victim here - but in some ways, the recording industry, they were slow to respond to produce digital products in an attractive legal alternative. It really took iTunes forcing their hand in 2003 to create an alternative in which one could purchase individual tracks at 99 cents.</p>
<p>It's an interesting case study in a response to technological change. Unfortunately for the music guys, they had to go first. And so the hope is that movies and other digital media can learn from the experience of music.</p>
<p><strong>Romesh</strong>: I'd like to come on to that in a moment. But just talk a little bit more about the impact of iTunes, and how that's trying to establish a price, rather than the zero price that these young people were downloading at.</p>
<p><strong>Joel</strong>: Yeah. It's interesting, iTunes of the course the Apple Corporation is in the business of selling hardware, and most of their&hellip;they get $8 billion in a recent year from selling hardware, and less than $2 billion from selling songs. At the time, I think they were paying about 70 cents wholesale price per song, selling them for 99 cents, and there was lots of promotional expense. It's not even clear how much money they made on the song side.</p>
<p>But of course the hardware's only valuable if there's music to play on it, so I think it was at least a very nice gesture on their part to try to produce a way to make money from music.</p>
<p>The labels view it a little differently. They'd like to have a lot more control over pricing and so forth. But at least Apple's behavior created a digital market.</p>
<p><strong>Romesh</strong>: The way we talked about music, you described it earlier as a stream of services. It's something that we're not placing a value on, so there's something going wrong with the market. There's some kind of market failure here. Is that how you see it?</p>
<p><strong>Joel</strong>: At least I would say there's a failure of business models. We've had this technological change that's made it harder to appropriate value from selling physical recorded music, or any recorded music. At the same time, though, look around and you see that the stream of services coming off digital products is higher than it's ever been. Just look at how many kids, or grown-ups for that matter, are walking around listening to music. Look at how usefully one can obtain the newspaper over one's phone. All these digital products are ubiquitously available and, I think, generating higher service streams than ever before.</p>
<p>But at the same time the revenue streams, especially in music and newspapers, are at unprecedented lows, at least in recent times.</p>
<p>So that's not necessarily a market failure, but it's a period in which, I think, firms are groping for new business models to try to figure out a way to capture those benefits as revenue.</p>
<p><strong>Romesh</strong>: Let's go on and talk about the movies, because as you say, that's the industry that feels the fear the most. That seems like it could almost be damaged much more than music, because it takes much more to put together a movie. These are million dollar ventures.</p>
<p><strong>Joel</strong>: Yes. And clearly those multi million dollar ventures aren't done for fun in the garage. Some people think the Hollywood type movies with lots of explosions in them aren't so great, but the market has spoken, right? These are valuable. Movies are valuable in a couple of way, in comparison with music. First of all, the files are much, much, much larger, which means they're a fair bit harder to steal over the Internet. At least if you want high quality copies. And that's good news for the industry. I think it's forestalled some of the problems for Hollywood.</p>
<p>But another feature of movies makes them more vulnerable. With music, I can steal tons of music, much of which I would not have purchased. But with movies, if you think about the real cost of consuming a movie, there's the money cost and the time cost, and it has to be consumed with undivided attention.</p>
<p>So even when it's free it costs me two hours, let's say. Well, even a student has a limited time budget. And so if I steal five more movies this week and watch them, that really is going to eat into the time I have to watch movies that I'll pay for.</p>
<p>So I have revisited the sales displacement question with surveys of students, and what I found there was a very low amount of unpaid activity in the U.S. It was actually at the University of Pennsylvania, one particular part of the U.S. But a really high rate of sales displacement, virtually one for one.</p>
<p>And again, I think that's because the real cost of watching a movie is mostly the time cost. So if I were Hollywood, I'd be very scared about this. Once it's easy to steal, I would worry the rate of displacement would be really high.</p>
<p><strong>Romesh</strong>: What about an area of digital content which you and I probably engage with the most, which is the written word? We used to read newspapers. We still read books. We hope that books will continue. You've just published one. How do you see that playing out in terms of the evolving business models? We're seeing some corporations trying to charge for online content, Rupert Murdoch, Wall Street Journal, these kind of places.</p>
<p>How do you see that playing out? Is there going to be some kind of solution to the mismatch there between the cost of producing these things and what consumers are willing to pay?</p>
<p><strong>Joel</strong>: Well, I think in newspapers, nobody got in quickly socializing people to pay for content. It's been very, very hard to get people to pay for content. I know Rupert Murdoch is talking about trying to do it. Wall Street Journal is able to do it with a pretty differentiated product targeted to rich people. But the newspaper industry has had a lot of trouble. Books I worry about enormously for two reasons. One, the real cost of reading a book is time. So if I can get it free and I read it, it's really going to eat into my time budget for reading other things. And the other things is that book files, text is really&hellip;those are very small files. They're very easy to transfer over the internet.</p>
<p>I think an encouraging development, not withstanding the monopoly problems, but an encouraging development is Amazon's development of Kindle. They're not the only folks in this area, but I think they've tried to establish this product before there's really an active market, for lack of a better word, in stolen books.</p>
<p>And so if they can get people accustomed to using their product and again, there's some issues about monopoly here - but if they can get people accustomed to paying for books through that platform, then maybe they can keep revenue coming to books before it's a lost cause.</p>
<p>With music, there's a whole generation of people who will never pay unless somebody hits them over the head.</p>
<p><strong>Romesh</strong>: Final question for you, Joel, what's the role of government in all this? We started off talking about illegal file sharing of music. In a sense, it's the legal framework within which this all operates, isn't it, that's at issue?</p>
<p><strong>Joel</strong>: Yeah, it's a big question. One of the things the industry has tried to do is to try to get things like internet service providers to do blocking and filtering, and there's a lot of lawsuits and policy discussions around the world. So this is way to use the legal framework to sort of impose the responsibility of enforcement on somebody. We'll see how it plays out. I think it could be very beneficial, certainly to the sellers of music, but there are issues about net neutrality and about sort of common carrier status of pipes, so it&rsquo;ll be an interesting decade.</p>
<p><strong>Romesh</strong>: Joel Waldfogel, thank you very much.</p>
<p><strong>Joel</strong>: Thank you. <br />
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